A Chinese steel worker walks past steel rods at a plant on April 6, 2016 in Tangshan, Hebei province, China. (Kevin Frayer/Getty Images)A Chinese steel worker walks past steel rods at a plant on April 6, 2016 in Tangshan, Hebei province, China. (Kevin Frayer/Getty Images)

One year after the mini-devaluation of the Chinese currency, China is getting desperate about its corporate debt situation and is directives to evergreen loans. According to an Aug. 8 Caixin report, the banking regulator is now telling banks to get rid of bad bank debt by swapping it for equity.

Local media Caixin reports that the China Banking Regulatory Commission (CBRC) issued a directive to encourage government owned so-called Asset Management Companies (AMC) to buy bad loans from banks. This exercise worked well during the last banking bail-out at the beginning of the millennium and China has prepared itself for another round since 2012, when local governments started to set up 27 new AMCs. 

Instead of keeping a loan that a company can’t repay and writing it down, the bank would get an equity stake in the company. Because banks aren’t allowed to hold equity in companies, they would sell the equity stake to an AMC at a price the bank can afford without hurting bank equity too much. AMCs would get the money from local or the central government or the central bank. 

The directive says that firms in the troubled steel and coal sectors will be the first to try the arrangement. However, only companies should be supported which have made efforts to cut overcapacity and improve profitability and whose problems are temporary, similar to another directive by the CBRC and first reported by Chinese National Business Daily about rolling over defaulted loans. 

(Société Générale)

(Société Générale)

“A Notice About How the Creditor Committees at Banks and Financial Institutes Should Do Their Jobs” tells banks to “act together and not ‘randomly stop giving or pulling loans.’ These institutes should either provide new loans after taking back the old ones or provide a loan extension, to ‘fully help companies to solve their problems,’” the National Business Daily writes.  

The recent leaks in relatively quick succession may be proof of hedge fund manager Kyle Bass’s concern of “the Chinese corporate bond market freezing up,” as he said in an interview with RealVisionTV in June. “We are seeing the Chinese machine literally break down.

“In the West, the speculation is always about the Lehman moment in China. That is a Western fantasy. Chinese politicians know what’s coming up and have a plan to manage the bad loans,” Horst Loechel, an economics professor at the Frankfurt School of Management told the Wharton Business School. Evergreening and debt for equity swaps seem to be that plan.

Kyle Bass estimates bad loans in Chinese banks could lose up to $3 trillion in bank capital if all loans were properly written down. 

In transactions from 2015, where banks sold defaulted loans to AMCs in Zhejiang province, they only received 32 percent of their original value, down from 43 percent in 2014 according to a regional AMC manager quoted by Caixin.  

The announcement comes in the wake of seven government-owned coal miners in Shanxi being allowed to extend maturities on existing debt, according to state mouthpiece Xinhua, a shipbuilder failing to make a payment on a $60 million one-year bond on Aug. 8 according to Bloomberg, and a developer defaulting on a $380 million offshore bond in Hong Kong, according to the Wall Street Journal. 

For good measure, the National Association of Financial Market Institutional Investors (NAMFII), an organization backed by the central bank, has enquired with major banks and brokers to see whether it would be possible to roll out a credit default swap market in China, according to the Wall Street Journal. Credit default swaps are insurance contracts on bond defaults, precisely what China needs right now.

According to the report, the regulator responsible for the $8.5 billion corporate bond market with soaring defaults, is drafting rules to make Chinese CDS compliant with international practices. The Journal reports that the regulator will soon ask the People’s Bank of China (PBOC) for approval.

After 39 defaults this year totalling $3.8 billion, it is about time. 

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A Chinese bank worker prepares to count a stack of US dollars together with stacks of 100 Chinese yuan notes at a bank in Hefei, Anhui Province, on March 9, 2010. (STR/AFP/Getty Images)A Chinese bank worker prepares to count a stack of US dollars together with stacks of 100 Chinese yuan notes at a bank in Hefei, Anhui Province, on March 9, 2010. (STR/AFP/Getty Images)

One thing is for sure, the Chinese yuan just had its worst drop on record ever since the last currency in 1994. The yuan lost 2.9 percent against the dollar since the end of March to 6.64 on June 30. 

Another sure thing: Brexit didn’t help as the yuan devalued almost one percent in a single day on the Monday after the historic vote. This is where the certainties end and where speculation and confusion starts.

Performance of the Chinese yuan (Bloomberg)

Performance of the Chinese yuan (Bloomberg)

It is speculation that China used the cover of Brexit to ease renewed pressure from capital outflows, which ebbed off to $20-$30 billion per month after $100+ billion run-rates in the first two months of the year. The 1 percent drop on Monday took the currency close to six year lows and could have been a welcome opportunity to do this, as everybody else was watching how markets in Europe reacted to the Brexit. Before, China’s currency has been dominating headlines and global markets since the first surprise devaluation in August of last year and any sharp devaluation was not received well.  

On the other hand, traders could have just taken some risk off the table because of the global spike in volatility. Another indication that the Chinese currency will enter the safe haven status anytime soon. 

On the policy side, things are even more confusing. Despite the steep drop and relative volatility, Chinese state newspapers want the world to believe that there is no pressure on the currency. “Although the yuan’s mid-point fell against the U.S. dollar on consecutive days, the mood in both on-shore and off-shore markets is basically stable with no signs of panic-selling or a scramble for foreign currencies,” the Shanghai Securities News reported, citing industry experts as saying.

Panic selling is a vague term and may be more applicable to the British pound, but stability in the onshore and offshore yuan markets also looks different. 

Although the regime is maximizing for stability, it doesn’t mind that Reuters quotes other government economists later in the week who claim the central bank would be happy to see the yuan at a rate of 6.8 per dollar. “The central bank is willing to see yuan depreciation, as long as depreciation expectations are under control,” Reuters cites unidentified sources.

The place to start getting things control: Unidentified economists.   

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